Shares plunged to $24.52 from over $43 in mid-January. On Feb. 13, 2020, the Company provided 4Q/19 earnings, which were mostly in line, though China-based revenues were down sharply (pre-virus).
Sales guidance for Q1 indicated declines of -18 to -23% expected year over year. For the 2020 fiscal year, management reduced full-year guidance to reflect -5 to -10% sales declines.
Timing of COVID-19 is particularly inconvenient for NUS, given the Company has been dealing with substantial regulatory disruption, and is on the cusp of a major product launch.
We expect further estimate downgrades in the first half of this year as the Company’s full-year estimates imply that impacts of COVID-19 are resolved by 3Q.
Shares of Nu Skin Enterprises Inc. (NUS) have not been immune to negative economic impacts from the COVID-19 outbreak. The Company operates a multi-level marketing business model for personal care products. We believe there is further downside to 2020 revenues and earnings estimates based on Company geographic and business model exposures.
Nu Skin is a multi-level marketing company focusing on personal care and dietary supplements. The Company has faced scrutiny from regulators, most recently in China, regarding allegations of being a "suspected illegal pyramid scheme". Nu Skin was forced to a $47mm settlement in a U.S. court in 2016 related to the Chinese allegations. Post an S.E.C. probe, the Company paid $750k to induce a senior Chinese official.
The nature of Nu Skin's business model means that it is very exposed to momentum both in product mix and in being able to employ new distributors who sell directly to new customers. Distributor sales are carried out in fairly traditional personal sales methods including demonstrations, trade shows, and meetings.
The Company is highly exposed to Mainland China, South Korea, Japan, Hong Kong, and Southeast Asia. These regions are among the most highly exposed to the COVID-19 threat.
Given the nature of the Company's product (consumer discretionary), the distribution model (primarily in person) and geographic concentration, we argue there is a substantial risk for the Company failing to meet 2020 estimates.
Nu Skin Geographic Exposure
Source: Company Presentation
Revenue and Earnings Guidance
During 4Q/19 earnings, NUS provided its initial revenue outlook for FY20, calling for revenue of $2.17-$2.30 billion. This compares to $2.42 billion in revenue in FY19, representing an approximate 7.7% decline. The Company expects the majority of the year over year decline in sales to occur in the first half of the year. The Company expects 1Q sales growth to decline -18% to -23%, implying about -12% for 2Q.
Nu Skin claimed to have very little visibility on H2/20 operating results. Based on their H1 and full-year revenue guidance, the Company is implying H2 revenues of approximately $1.21B, which represents a positive growth rate of 3.2% compared to the second half for 2019. We believe that there is a good chance that full-year guidance needs to be taken down further, based on the implied growth rates in the second half.
Operating Income reported missed street estimates by just over 10%, coming in at $24.9 mm. The Company indicated that the operating margin was expected to come in at 9-10% for 2020, with 75-76% gross margins. Capex was guided to $78-$88 mm, part of which ($18 mm) is earmarked for new factory construction in China.
The level of sanguinity regarding H2/20 earnings and revenues is worth highlighting.
Past and expected financial results (green highlights represent Company guidance)
From the table above, it is clear that Nu Skin is projecting impacts of COVID-19 to have mostly dissipated by the second half of 2020. Given turmoil in the global supply chains are facing, and the momentum that multi-level marketing requires among program distributors to maintain and grow sales, we believe that Company expectations are overly optimistic.
Source: Company filings
Valuation and Outlook
Throughout 2019, Nu Skin traded at approximately 10-14x forward EPS. Given uncertainty from the macro and regional backdrop, the lower end of the recent valuation range (10x fwd EPS) is appropriate. Competitors trade with much higher valuations given the size, scale, distribution, and strength of products. Competitors include Revlon, Estee-Lauder, Proctor & Gamble, Clorox, and Colgate-Palmolive.
Nu Skin Historical Valuation (white line below)
Comparing newly instated H1 guidance as a more likely roadmap for H2, taking a cautious approach, we estimate the Company will generate just $1.71 in EPS, versus $2.21 using management's scenario of a strong second-half bounce back. Using management's inputs to derive earnings, and applying a 10x forward P/E multiple, we arrive at a $22.10 target. Using the cautious scenario, we arrive at a $17.15 target.
Needless to say, given the risks facing Nu Skin, and the likely reductions to H2 guidance, we believe a 10x forward P/E multiple is appropriate, particularly for a company that has failed to grow revenue or earnings meaningfully in years.
Nu Skin pays a dividend of $0.375 per quarter, which implies a 6.13% dividend yield. The Company generates free cash flow, has long term debt of $334mm through a revolving line and a term loan, and has just $163mm in net debt. We would consider the dividend to be safe, given a strong balance sheet, history of dividend increases and free cash flow generation. Given the current market uncertainty, along with planned Chinese factory CAPEX this fiscal year, we do not expect the Company to increase the dividend near term.
Conclusion and Recommendation
Even though Nu Skin shares have sunk just over 30% since reporting 4Q earnings on Feb. 13, 2020, we believe there is a further downside in shares. Management took an optimistic view of revenue and earnings potential in the second half of 2020 rebounding back from even H2/19 levels. The Company has a high concentration of COVID-19 infected operating regions. The business model requires distributors (salespeople) to be actively soliciting new clients through sales initiatives. We believe that priorities for consumers and distributors during this period do not bode well for Nu Skin's profitability to return to 2019 levels, which were already demonstrating slowing growth. At share price levels below $18.00, we would consider buying shares of Nu Skin if current trends haven't deteriorated further, and if management's H2 estimates are further reduced.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.